As the longest-serving chairman of the Securities and Exchange Commission, from 1993 to 2001, Arthur Levitt made a name for himself as an outspoken advocate of investor protection and a critic of conflicts of interest on Wall Street and in the accounting industry. In this interview, he tells FRONTLINE that the recent $1.4 billion settlement between regulators and Wall Street firms means little without a complete separation of research and investment banking and without "public revelation and public admission, by all parties across the board, of what went wrong." He also recalls the debates over repealing the Glass-Steagall Act during the late-1990s, a move he felt would increase conflicts of interest in the banking industry. A former investment banker himself, Levitt was a partner with Citigroup chairman Sandy Weill in the firm of Cogan, Berlind, Weill & Levitt, which later became Shearson Hayden Stone (now part of Citigroup). From 1978 to 1989, Levitt served as chairman of the American Stock Exchange. This interview was conducted by FRONTLINE correspondent Hedrick Smith on Jan. 13, 2003.

We just had a settlement between the regulators and the big Wall Street banks. Did that settlement regulate things? Has that fixed the problem of analyst conflicts and bank conflicts?

I don't think so. I think that settlement was arrived at by a very creative and determined attorney general of the state of New York, Eliot Spitzer, but it didn't complete the job by any means. The firms were fined, to be sure. Various protections were put in. Additional sources of research were provided for. The solution that we've seen is companies are walling off their analysts from their investment banking, but they are still under the same corporate umbrella. In my judgment, that makes the problem a little bit better, but it doesn't cure it. The perceptual image of a firm that is conflicted is still there, and whether it is perceptual or real is questionable. I don't believe in Chinese walls. I don't care if you build them higher or thicker. The only answer to this is total separation of research and investment banking, and we don't yet have that.

What about the culture of Wall Street? Does the culture of Wall Street have to change?

I don't think there's any industry in America which has more conflicts than Wall Street -- not illegal, but they're there. And unless investors know about them, unless investors are skeptical and cynical, they'll buy into some of the same problems they've always bought into.

From an investor's standpoint, what's wrong with conflicts? What's the danger of conflicts of interest?

When the interests of the purveyor of a financial product differ from the interests of the buyer of that product, you have a problem. ...

When an investment bank is raising money [from the general public] for a corporate client, and places the interests of the bank and the corporate client above the interests of the individual investor, you have a problem. The problem is one of trust. If the individual investor doesn't trust the system, our capital markets run a systemic risk. Trust is the foundation of our markets. ...

[With this settlement] we've moved the ball somewhat, but the problem is still very much there. We need to continue to be wary.

I think the best answer to this ... is full disclosure. ... Have we heard from the firms precisely what they did? Have the firms told the world, told investors, "Yes, we compromised your interest in favor of our corporate clients' interests. Yes, we tried to promote the interests of WorldCom, we tried to promote the interests of AT&T, at the expense of investors?"

Unless we hear that, the settlement doesn't do all that it could do, and that is ultimately a far better solution than any amount of money you can extract from the firms. The money is relatively meaningless.

How tough are these fines for these firms?

I think the fines are symbolic, and no amount of money will ultimately be judged to be satisfactory. The best response to all of this would be the confession of the firms to what they did wrong.

So what you're saying is Sandy Weill [of Citigroup] and Bill Harrison [of J.P. Morgan Chase] and the heads of these groups, should have come forward and admitted to the public what they did wrong?

I think that a satisfactory settlement of this issue would involve a public revelation and public admission, by all parties across the board, of what went wrong.

What went wrong in the 1990s ... in terms of Wall Street?

There was nothing new about the 1990s. We've been down this road a number of times before. It related to a runaway bull market and the kind of euphoria that that brings about, where an analyst saw every recommendation go up, where brokers saw every stock that they recommended to their clients work out, where investors believed that their every judgment was correct.

All of them thought it was their own genius rather than the sweep of the market which carries along bad with good. This very market propelled a kind of mystical thinking which made things seem possible which were preposterous. Companies and investment banks moved closer and closer to the line, and then over the line.

The law?

Yes, in their zeal to outdo one another. And nobody was paying much attention to anything, because this was a "new paradigm." This was a new world, in which we would never again see a market decline. So the sense of power, the sense of excess, the sense of omnipotence that carried along huge salaries, enormous compensation, tremendous payoffs, fueled the kind of thinking that ultimately undermined the system and destroyed public confidence.

Somebody said to me not too long ago, "Wall Street induced this boom. Wall Street fueled it, Wall Street funded it, Wall Street sold it." Talk to me about your view of how Wall Street was connected with this boom.

Wall Street is used as kind of a proxy for the thinking of society. What is Wall Street? Wall Street is a point on which millions of voters all over the world are casting ballots every day on stocks that either go up or down. Wall Street doesn't act in a vacuum. They act in the midst of a public feeding frenzy, and they help that. They help fuel the frenzy by research, by promotions. But don't disregard the media as well. All of this -- the media, the accountants, the lawyers, the standard setters, the rating agencies -- all the traditional gatekeepers were asleep at the switch, and indeed were participants in a party which created a massive hangover that we're experiencing today.

As a regulator, as the head of the SEC through the 1990s, at what point did you start to get worried? And what made you worried?

I was worried before I came to the SEC. I saw this frenzy building. And what I saw when I got to the Commission was the power of the business community as it exerted their influence on Congress. Congress defied just about every pro-investor initiative that the Commission came up with.

They did that because of the vast amount of money flowing into their campaigns from a business community that, in the past, had at least tried to negotiate with their regulators. But during the 1990s, they went directly to Congress on any issue that concerned them. Congress then tried to tie up the regulator in an endless series of hearings and letters and communications to prevent pro-investor regulations, pro-investor initiatives.

Where were the analysts? ... You made a number of speeches on this subject in the late 1990s, and you ticked off some things. ... What was it that analysts were doing that they shouldn't have been doing, in your estimation?

Analysts who should have been providing good, objective, unbiased information to both individual and institutional investors became handmaidens to the investment banking departments of the firms that employed them. ...

What was your reaction when Jack Grubman of Salomon Smith Barney testified before Congress that he had attended three meetings of the WorldCom board of directors?

I wasn't totally surprised, and I felt that this was part of a culture of seduction that had been created over the 1990s. That had caught up just about every major analyst we had ever heard about at that time.

But from the standpoint of an ordinary investor ... hearing that for the first time, what's your reaction? ...

I think that Grubman was one of many analysts during this period of time that went over the line, that abused their trust ... by compromising the interests of investors in favor of the interests of his company.

What do you assume Jack Grubman was doing at this WorldCom board meeting?

I would assume that Grubman was trying to cement the relationship between the company and the bank.

What happens here in the relationship between the bank and a company? People have told me you ought to really see this, in some ways, as Citigroup and Salomon Smith Barney really doing the thinking for WorldCom, that analysts often come up with ideas. "Well, you ought to merge with Sprint, you ought to merge with MCI." Bernie Ebbers, after all, the CEO of WorldCom, grew his company by acquisition. What's the relationship there between a guy like Grubman and a guy like Bernie Ebbers at WorldCom?

This is not a phenomenon of the 1990s. It's something that I saw in the investment banking business when I was there. It is not unusual for an analyst -- who comes to understand a company, probably as well as anybody outside that company can -- to come up with an idea for a merger, an acquisition or a corporate strategy. That is not at all unusual. We probably saw more of it in the 1990s because ... analysts in their relationships with the companies became closer than ever.

So, in a way, the analyst becomes the brains for the company's CEO?

To some extent, the analyst does supplement the company's CEO, if the analyst is astute enough and creative enough. ...

If you've got Grubman at the WorldCom board meetings, how objective is his analysis going to be? ... What does it say about Grubman's ability to analyze these companies, if he's going to board meetings?

You can argue that in several directions. If I was Grubman's employer, I'd want him to get as close to a company he's writing about as I possibly could, to understand that company backwards and forwards, but to also have the independence to call the shots as he saw them. I guess I'd be concerned if I felt he was being seduced by the company. ...

If you're talking about it from the standpoint of the SEC -- who is regulating on behalf of ordinary investors -- and you're talking about ordinary investors, how do you react?

I would want to be certain, from the standpoint of investors, that Grubman is totally, absolutely independent. But I couldn't very well challenge the closeness of the analyst to the company, because that's what analysts are supposed to do. They're supposed to get close to companies.

Where we go across the line is if the analyst is being seduced by the company and induced to say something that he doesn't believe to be accurate.

And how do we know when that happens?

You know that after the fact, unfortunately. You know that if his writings turn out to be creative rather than objective. ...

When you look at the behavior of analysts, when you look at what became the practice of analysts in the 1990s ... what were the kinds of things that analysts were doing that made them suspect in the minds of the public, and for a regulator?

I think the basic conflict developed when analysts became the partners of the investment banking departments, rather than purveyors of information to the investing public. Analysts then went out to pitch investment banking business. Analysts went on television and in print media to promote companies that were investment banking clients of their employers. Analysts were paid, not on the basis of their recommendations for public investors, but paid on account of the business that they brought in for investment banking purposes. ... Analysts were marketing, rather than analyzing, and lacked the independence to provide the kinds of reports that were objective. ...

What happened? Was this all just a frenzy -- everybody is making so much money, it doesn't really matter? The market is going up, maybe you're wrong by a few points, but what difference does it make? I mean, what is it that changes it all? The euphoria?

Well, the euphoria is the backdrop for all this. But just think of this. You have dozens of investment banking departments chasing the business of hundreds of companies that are seeking financing in an overheated market. So the competition involves companies trying to decide between investment bankers. Here you have the analysts making pitches, and the companies say to the analysts, "Look, we'll choose your employer, but we expect coverage." What they mean by "coverage" is, they expect that analyst to write favorable research reports about their company.

So there's a quid pro quo?

There's an absolute quid pro quo. And were the investment bankers saying, "Oh, no, we're not going to write any reports about your company"? No, the answer invariably was, "Of course, we have Institutional Investor's number one retail analyst, and of course we're going to cover your company."

Now, what does "coverage" mean? Certainly not a "sell" recommendation. Coverage means, "We're going to promote the heck out of your stock." ...

So it isn't just euphoria, it is the way Wall Street is structured? The incentive for the investment banker is to go out and get business. Never mind whether or not the company is sound or not; get the business. "We get the fees. Let the public worry about it"? ...

I think that what we're talking about is a period of time where everybody was making so much money, where the natural competitive juices of American business -- which is probably at its highest in the investment banking business, where such big amounts of money are involved -- that what was acceptable behavior and what was unethical behavior became fudged. Practices that were really unethical had begun to be accepted as ordinary competitive devices. That was unfortunate, because while it benefited a few, it hurt the system -- and hurt it grievously.

You're talking about insiders versus outsiders?

Absolutely. We always have insiders and outsiders. But the disparity between the two, the weighting between the two, was so skewed by this market that the system was hurt, and that confidence evaporated. ...

There is always a difference between what the purveyors of information, the investment banks, the commercial banks, know about companies and what investors know about companies. There is always a certain amount of imbalance. But the practices that were fueled by the euphoria of the 1990s, the movement toward practices that went over the line into unethical practices, were such that the public was taken advantage of, and hurt.

Investment banks and commercial banks made vast amounts of money at the expense of investors, who were too willing to go along with the kinds of deceptions that were being practiced.

But [investors were] basically in the dark?

Basically in the dark, but all too willing to buy into this game, because everybody was playing it. You can't leave the public out of this. You just can't do that. They were willing dupes in this. Really, in fairness, the public has some responsibility.

And so, you said earlier, does Congress.

Oh, absolutely.

Last night I was reading some of your testimony about the repeal of the Glass-Steagall Act. Again and again, you worried about investor protection. Again and again, you're worried about changing some rules that came to us from the 1930s, but not changing other rules. What happened in Congress? ... When you came in as head of the SEC in the early 1990s, what was the situation with Glass-Steagall and the banking laws?

It was apparent to me that the protections of Glass-Steagall had already largely eroded. But Congress, at several times, nearly passed a bill to do away with Glass-Steagall. It was clear that it was a question not of whether but when Glass-Steagall would go. Millions of dollars were pouring in the campaign coffers of senators and congressmen who were set to do this.

Who was pushing?

The insurance industry, the Federal Reserve Board, the White House, the investment bankers, the commercial bankers -- just about everybody wanted it. ...

It was an incredible scene, but I saw it played through twice. Once was during a period of time when Al D'Amato chaired the [Senate] Banking Committee -- and was not successful in getting the repeal of Glass-Steagall -- where hundreds of lobbyists descended upon the Congress, were in the hallways morning, day and night. Lobbyists for the insurance companies, for the investment banks, for the commercial banks, pulling for their own parochial interests.

Then when Phil Gramm became chairman of the banking committee, the same group came down, only they were now supplemented by lobbyists for the derivatives industry, for other new products that had developed, and for the stock exchanges and the options exchanges. They were buttonholing senators and congressmen, morning, day and night.

From the standpoint of investors, I was concerned that the vital investor protection, in terms of SEC oversight of securities matters, would be eroded by turning over to the banks all of the responsibility for initiatives that, in the past, were the province of securities firms under the SEC jurisdiction.

This wasn't merely a turf battle. This was a question of two different cultures: a culture of risk, which was the securities business, and a culture of protection of depositors, which was the culture of banking. Two very different cultures. ...

Were you worried about a climate in which anything goes? "Trust the market, and the investors can take care of themselves?"

Yes, I worried about the power assumed by the commercial banks that now had the ability to be a financial services warehouse that could satisfy the needs of everybody, but whose overriding interest, I felt, would favor their corporate interests as opposed to the individual investor. I thought that a lot of the protections that many of the retail brokerage firms had, in terms of the retail investor, knowing their customer, would be lost in combining brokerage and commercial banking and investment banking.

So you worried that the individual investor and depositor and their protections get lost in the superbank concept?

Yes, I was very worried about that, because I felt that the culture of banking and the culture of investment banking were so different. ... The lure of investment banking and the amount of money that that meant to the commercial banks was so much greater than whatever they got from depositors that the weighting of their emphasis would favor commercial business over the individual investor. ...

Let's go back to Glass-Steagall. ... The idea was separating different kinds of banking so that you didn't get the kind of collapse that you got in 1929, isn't that right?

Yes. ... Glass-Steagall was enacted [in 1933] to respond to some of the scandals of the early part of the century, where individual investors were grievously hurt by banks who were promoting stocks that were of interest to the banks, rather than to investors. That was a very sensible division of investment banking and commercial banking.

What worries me about combining those two interests once again is the inducement, the likelihood, that commercial banks will tie their lending activities to their investment activities. ...

There's another danger. ... You were worried about the erosion of the standards of commercial banking. ...

The kind of scrutiny that a commercial bank would give to a loan has to erode, by virtue of the fact that that borrower has lots of alternatives. One of the inducements offered to that bank would be, "We'll give you not only our lending business but we'll give you our investment banking business, as well." ...

Let's say that a commercial bank underwrites a company. Millions of shares are outstanding in the public's hands, and the company's fortunes sink. Ordinarily, that commercial bank would place the interests of their depositors above all others at that point, and if the loan didn't make sense, they'd call the loan, or they wouldn't give them additional funds.

What kind of judgment are they going to make at this point, where they have perhaps a million investors out there who have bought shares in the company that their name is on? They will probably go a step further and lend more money and more money, and more money. Then we have the shareholders in the bank and the depositors in the bank at risk. ...

Will that bank have the same kind of restraint, the same kind of controls on their lending operation that they might have had if they were free of that investment banking obligation to the millions of shareholders that they've marketed shares to? ... You can't let this company go down. It's the reputation of the bank that's at stake now. So that's where the nexus of Glass-Steagall becomes very, very sticky. ...

The merger of investment bank and commercial bank interests has created conflicts of interest that clearly hurt the public investor. Only extraordinary activity by both the banking and security regulators can begin to address an issue which I'm not certain is addressable.

Why is there this danger for ordinary investor in this merger?

Because the ordinary restraints that would be imposed upon the commercial banker, in terms of lending practices, are distorted by their distribution of shares in a company in which they, to some extent, become partners.

So the commercial bank's judgment, in a way, becomes corrupted by the enthusiasm of its investment banking division?

The commercial bank's judgment becomes seduced by the interests of the investment banking division, and is clearly impacted by that -- both perceptually, and, in some cases, in reality.

You were talking about these lobbyists descending on Congress in droves, hounding people and grabbing them in the hallways. What were they after?

They were after the most deregulatory environment they could possibly get. ... You have the brokerage firms, the insurance companies, the derivatives sellers, the stock exchanges -- all wanting the most deregulatory environment they could have in this new world. This was their chance to be able to create a vast supermarket of financial services with the least possible regulatory oversight.

What had been going on in the 1990s? Was this really capping off a trend that had already been well under way?

I think that's true, that many commercial banks had fallen into the practice of combining their commercial bank activities with investment bank activities. The Citigroup structure had already been arrived at before the passage of this bill, and the bill merely ratified what was already a fact of life. Glass-Steagall had so eroded, that all it required was the legislative blessing that it eventually got. Millions of dollars of campaign contributions over the past ten years were extracted by Congress to come up with a bill that they finally had to come up with. ...

Now this had been going on because at the Federal Reserve, which oversees banking, they had gradually been granting more and more exceptions to Glass-Steagall. Can you explain that to us? It wasn't just that Glass-Steagall was eroded. There were decisions being made. ... It wasn't just happening in the marketplace. What had been going on in the 1980s and 1990s?

Clearly, over the 1980s and 1990s, a number of exemptions were granted by the Federal Reserve regulators, in terms of what banks could and could not do. The Comptroller of the Currency had involvement in this, as well. ... They allowed the banks to do things that they could not do in the past. They permitted certain practices that were not acceptable in the past, and as a result of that, the protections of Glass-Steagall were almost totally eroded by the time this bill passed. ...

So when Congress finally acts, it's basically to ratify?

Congress gave legislative sanction to practices that the regulators had allowed to develop over the past two decades.

The dramatic development, in 1998, was the merger of Citibank and Travelers. ...

The merger of Travelers and Citibank was the death knell of Glass-Steagall, obviously. ...

You've mentioned before that Sandy Weill had a good nose for danger, and that he was risk-averse. How did Sandy Weill get in so much trouble at Citigroup with WorldCom, the telecom industry, the analysts?

I really don't know. I don't know enough of what his involvement may have been or may not have been to be able to comment on that. ...

What does it mean to the financial markets when the leading financial institution of Wall Street and of the country gets dragged into this kind of public disclosure, where you've got Jack Grubman saying, "The boss helped my kids get into the 92nd Street Y in connection with my rating of AT&T?" What happens? What does that mean to the market?

I think the symbolism of large companies, large banks, investment banks being involved in conflicts that hurt the public investor, erode public confidence in our markets.

How serious is the problem? I mean, when you look at what's happened -- particularly when it's focused on institutions the size of Merrill Lynch and Citigroup -- what's the implication here? We're not talking about the Bank of Denver, and we're not talking about Rhode Island National Bank or something like that. What's the implication for our markets?

I think when institutions of that size are involved in the kinds of conflicts that we're talking about, we have a systemic problem involving loss of public confidence. But the humiliation and embarrassment that this has created, in my judgment, has developed the very solution to this problem on a short-term basis. Corporate America has changed the culture of the boardroom.ĘThe kinds of response to the public disgust with these activities is far greater than anything we could have seen in the absence of the disclosure of these conflicts and these scandals.

Accountability is a strong principle in American corporations and in American law. Very little personal accountability has been assessed in this enormous scandal. Is that good or bad? Do we need more personal accountability?

I think that personal accountability is something that will play out in the courts, to the extent to which it's available. You're talking about laws that are very precise, but also very difficult in terms of tracing individual responsibility. But to the extent to which there is individual responsibility, a lot of that will be played out in the courts. In those instances where there has been criminal activity, I have no doubt that individual responsibility will be assessed.

Ivan Boesky and Michael Milken went to jail [in the 1980s]. I haven't seen anybody in the Wall Street part of this scandal go to jail. Will it take that to really get the serious attention of Wall Street?

I don't think so. I think Wall Street's serious attention is very much focused on this. I think that the actions of the Conference Board Commission on corporate ethics is something that couldn't possibly have taken place two years ago, in that an establishment group has come up with recommendations that I think will be largely accepted by the corporate community, that would have been laughed at two years ago.

So I think change is already taking place, and the change is cultural, which has far greater impact than legislative or regulatory change. ...

Do you think the regulators were deterred in their investigation of the current Wall Street scandals by a fear that, if they really nailed the top executive or major figures in any of the big firms like Citigroup or Merrill Lynch or J.P. Morgan Chase, that once again the markets would collapse?

Absolutely not. I have seen in my years at the Commission the appeals of companies, of banking regulators, of politicians, who said, "If you bring this case, it will jeopardize the interests of the country." When we went after the over-the-counter firms, when we went after Bankers Trust, those arguments were raised. That didn't impress us one single bit. Our system is based on full disclosure of regulatory misdeeds.

Well, Eliot Spitzer actually said on television, on 60 Minutes, that he was worried that if he indicted the top executive at Merrill Lynch, it would bring Merrill Lynch down. He didn't want to do that.

Well, I can only speak for the SEC. I think the SEC goes where it believes wrongdoing has been done. Certainly not at any time in my recollection has the Commission been deterred because of fear of consequences to the market. Not once.

As the chief securities regulator of the country in the late 1990s, you were watching analysts, investment banks, all kinds of people, behaving badly in terms of the interest of investors. How do you do something about it?

I did. Probably not enough, but clearly I understood from my own days as an investment banker what was going on with the analysts. I asked the NASD and the New York Stock Exchange to act on this and to provide rules that would prevent these conflicts. I sent them several letters, and urged them to do this.

What I failed to do -- and I should have recognized from my own experience running a stock exchange that the importance of the brokerage firms that bring business to the stock exchanges, and the importance of corporations which list on the stock exchange, was such that the NASD and the New York Stock Exchange were hesitant to bring about rules that they didn't bring about, until there was an eruption of an enormous scandal -- I didn't press the issue as much as I should have pressed the issue. But clearly, I could have done more than I ultimately did.

But you're also talking about a system of self-regulation -- the stock exchange, the NASD, they regulate themselves. But you're saying self-regulation doesn't work.

Self-regulation does work, but it has imperfections.

Some pretty big imperfections. ...

Well, ultimately, it was the stock exchanges that brought about the changes. Ultimately, the NASD and the New York Stock Exchange made the changes to eliminate these conflicts.

But not until Eliot Spitzer exposed them with the e-mails, with the power of an investigator.

I think clearly I could have done more than giving speeches and writing letters to the NASD and demanding that they and the New York Stock Exchange bring about a change, which they ultimately brought about two years later.

Why didn't they do it at the time?

I think they didn't do it at the time largely because they didn't perceive the danger to be as great as I did, and largely because the interests of their corporate and their brokerage clients were such that they were unwilling to face up to them and make changes, which were really Draconian in the way business was being done. It took a national scandal to galvanize self-regulators and regulators to do what we probably should have done some months earlier.

Was part of the problem that everybody was making so much money? Nobody wanted to rain on the parade?

Part of the problem was that only in an environment of crisis can the self-regulators galvanize themselves to actions that they couldn't otherwise take. We had Congress pressing us against any of these initiatives. We had Congress constantly bearing down on the Commission: "Don't take steps which would hurt the firms, don't take steps which would change the way business is being done." ...

When Congress sees these scandals taking place ... they become the latter-day Elmer Gantrys, protecting investors that they had abused so badly before.